Bitcoin: a cryptocurrency

One way to limit risk online is to use specialised payment methods that are designed for online use. One example that is increasing in popularity is the so-called cryptocurrency, Bitcoin.

Bitcoin

First emerging in 2009, Bitcoin was designed as an alternative currency which would be resistant to the problems of global finance. As Bitcoin creator Satoshi Nakamoto explained, normal currency relies on trust in banks, to hold and transfer our money, and to look after our personal information. We also rely on a central bank or government not to devalue the currency.

Bitcoin is a network which does not rely on trust. All transactions, verified cryptographically by users, are recorded in a decentralised public ledger known as the blockchain. This ledger allows anyone to see any bitcoin payments that have been made, and hence know whether any attempt at payment is using genuine funds or not. In this way it’s kind of like accepting debit card payments with the merchant having a full view of every transaction that has been made on the account.

The blockchain itself is not held by any one person. Instead, new transactions are added by users in blocks, and adding a block requires the person adding it (known as a bitcoin miner) to solve a difficult computational problem. These problems are set to be so difficult that they take so much computing power that large groups of people have to collaborate to solve them. The group that adds a block receives a profit for doing so, and this results in so much computing power being used that nobody is able to forge blocks. Hence users can trust that the blockchain is an accurate ledger of all payments that are made.

Bitcoin payments also support privacy in the shape of psuedonymity. Payments are made from “bitcoin addresses” which hold a value. This address is simply a number, and individuals can easily create new addresses. Nothing in the bitcoin network identifies the owner of a particular address, preventing a third party from seeing who the payment was made to and from. Payments are authorised using public key cryptography; a user owns a private key for each address and uses it to produce a signature when a payment is made.

Bitcoin is accepted for payment by an increasing number of online retailers. It does however have several downsides:

De-anonymisation: In some cases it is possible to discover who holds various bitcoin addresses. If an adversary can link a particular bitcoin address to a particular user (for example by getting hold of the shipping information for a product they bought) then it may be possible to figure out other transactions that user has made from the blockchain.

Theft: Anyone who can obtain the private key for a bitcoin address can spend any funds that are held by that address, and there is no way to retrieve them from within the system.

Loss of keys: If a user loses the private key to a bitcoin address then the money is unspendable and lost forever.

Exchange rates: Bitcoin is a currency in its own right and as a result the exchange rates with other currencies can fluctuate. Users who hold funds in Bitcoin have to risk the devaluation of these funds.

Bitcoin exchanges: A lot of users will need to convert funds to and from Bitcoin. This has resulted in the founding of Bitcoin exchanges that sell and buy Bitcoin in other currencies. These exchanges can be targets for the sort of financial frauds that users may turn to Bitcoin to avoid.